Public Finance in India

In this article we will discuss about the public finance in India:- 1. Evolution of Provincial Finance in India 2. Lord Mayo’s Decentralisation Scheme, 1870 3. Lord Lytton’s Reforms 4. Further Reforms-The System of Divided Heads 5. Quasi-Permanent Settlement, 1904 6. Permanent Settlements, 1912 7. The Montagu-Chelmsford Reforms 8. The Meston Award 9. The Government of India Act, 1935 and Other Details.

Contents:

1. Evolution of Provincial Finance in India
2. Lord Mayo’s Decentralisation Scheme, 1870
3. Lord Lytton’s Reforms
4. Further Reforms-The System of Divided Heads
5. Quasi-Permanent Settlement, 1904 
6. Permanent Settlements, 1912
7. The Montagu-Chelmsford Reforms
8. The Meston Award
9. The Government of India Act, 1935
10. Provisional Adjustments, 1947-1952 
11. Federal Relations under the New Constitution

---

1. Evolution of Provincial Finance in India:

Before the Charter Act of 1833 came into effect, the finances of the three Presidencies of Bengal, Bombay and Madras were kept totally separate. Bengal normally had a revenue surplus while Madras and Bombay ran deficits in most of the years. Accordingly, ‘investment’ in two Presidencies were financed out of the surplus territorial revenues of Bengal. The Charter Act of 1833 brought about a ‘coup de grace’.

The company was deprived of its trading functions and it became a purely administrative body supervising the Indian Empire on behalf of the Crown.

With a view to improving the administrative efficiency and keeping the territory firmly under control, the company introduced a system of centralised administration by vesting “the superintendence, direction and control of the whole civil and military government of all territories and revenues in the Gover­nor-General in Council.”

In regard to finance, “the Provincial Governments were left with almost no powers or financial control over the affairs of their respective provinces and no financial responsibility. Everything was rigorously centralised in the Supreme Government which took upon itself the entire dis­tribution of the funds needed for the public service throughout India.

It controlled the smallest details of every branch of the expenditure; its authority was required for the employment of every person paid with public money, however, small his salary; and its sanction was necessary for the grant of funds even for purely local works of improvement, for every local road, and every local building, however, insignificant.

Such a system in such a vast country was obviously absured. It divorced administrative responsibility from financial power and thereby encouraged extravagance. In distributing funds among the provinces, the Government of India acted on neither rational nor fixed principles.

The result was that the distribution of revenues became something of a “scramble in which the most violent had the advantage with little attention to reason.” Besides, as Mr. Ashok Chanda points out, “this arrangement created many administrative difficulties.

It led to constant differences of opinion and, as a consequence, constant conflict between the Central and local governments about petty details of expenditure.

On the other hand, the absence of an appropriate budget and an efficient machinery of audit rendered the Centre’s nominally complete control over Provincial finances into what Ambedkar calls ‘titular authority’ in practice. Economies affected by a local government in one direction could not be utilised in another direction without the express sanction of the Centre.

Rather, reduction in its expenditure by a local government was sure to be followed by a corresponding reduction in its share of the central revenues in the following year. In the words of Prof. B.R. Misra,”the centralised system of finance gave rise to financial irresponsibility and put a premium on inefficiency and extravagance.”

Such a system was sure to invite strong and frequent criticism. As early as 1835, Charles Trevelyan pleaded for reasonable control of local government in financial matters. It appeared absured to him that the local governments “should not be able to employ a chowkidar at Cape Camorin, or repair a tank at Tinnevelly without writing to Calcutta.”

In 1860, he emphasised the problems of ruling distant areas from one Centre and warned against the system where “the head is congested and the limbs are paralyzed.” In 1860, Mr. Dickens pointed out how this control was “regarded with feeling of aversion by the local Governors whose powers it curtailed and with whose acts it interfered.”

In 1862, Mr. Samuel Laing made out a strong case for financial decentralisation by emphasizing the urgency of breaking through “the system of barren uniformity and pedantic centralisation.” Meanwhile, with the passing of the company to the Crown, new economic and financial problems arose.

During the later half of the 19th century, the road system was vastly improved and extended while railway construction was planned and developed in a systematic way. This, along with general development of the country, resulted in an excessive financial burden on the Central Govern­ment.

There was a regular and heavy financial deficit which made it clear that it was urgent to reforms the system. Under pressure of financial difficulties, Mr. Massey received the discussion of the subject but Lord Lawrence’s personal and uncompromising opposition prevented the acceptance of the scheme of financial de-centralisation till 1870 when Lord Mayo gave his earnest attention to the problem.

---

2. Lord Mayo’s Decentralisation Scheme, 1870:

On 14 December, 1870, Lord Mayo, issued the famous Financial Resolution by which the Government of India transferred to the Provincial Governments the financial control of services like jails, registration, police, education, medical services, printing, roads, miscellaneous public improvements, and civil buildings.

To carry on these services the Provincial Governments were given an annual fixed grant of Rs. 4.68 crores from the Central revenues. In addition, the Departmental receipts in the case of services transferred also belonged to the Provincial Govern­ments. In short, subject to general restrictions, the Provincial Governments got full powers and responsibility so far as these services were concerned.

The new arrangement was certainly a great improvement on the old centralised system which had prevailed for half a century. The scheme was expected to encourage greater care and economy in public expenditure, import an element of certainty into the financial system and create harmonious relations between the Central and Provincial Governments.

It injected a sense of responsibility in the provincial Governments “both in the matter of collection of revenues and economy in expenditure.” They were encouraged to economise in the administra­tion and develop local sources of taxation.

The system was, however, not without its faults. Its greatest defect was that while it gave relief to the Central Finances, it also implied, as R.C. Dutt noted, a mandate to the Provincial Governments to impose fresh taxation. From the nature of the case, the services transferred to the provinces were such as demanded a constantly increasing expenditure.

In the face of fixed grants, the provincial Governments had no other alternative but to find their own resources by local taxes as was done in the Punjab, Bombay, Bengal and Madras, Secondly, the grants fixed were based on the actual expenditure of the year 1870 when the expenditure had fallen from the earlier high figure. Not only this.

From this reduced expenditure, a further sum was deducted, and the provinces were asked to make good the deficit by local taxes.

The most serious fault, however, lay in “stereotyping ‘he inequalities in provincial finance” in as much as the Settlements made in 1871 were based on the actual expenditure in the provinces for the year 1870-71 which, as Gyan Chand points out, in the case of Bombay was twice that of Madras and almost thrice that of Bengal. Thus were laid the foundations of inequalities in provincial finance.

---

3. Lord Lytton’s Reforms:

In 1877, another step forward in decentralisation was taken under Lord Lytton when all the remaining heads of expenditure, which were of provincial character such as land revenue, Excise, Stamps, General Administration, Law and justice, were transferred to the provinces.

In addition to the departmental receipts and the old lumpsum, grants, certain heads of revenue such as Excise, Licence Tax (now called Income Tax) Law and justice were made over to the provincial Govts.

This arrangement, though transferred some 20% of the revenues of India to the Provinces and imparted an unprecedented elasticity to provincial finance, did not eliminate the practice of making lump sum grants to the provinces to supplement their income and the usual scramble for getting the largest possible share in the distribution continued. These settlements remained in force between the years 1877-78 to 1881-82.

---

4. Further Reforms-The System of Divided Heads:

During the Viceroyalty of Lord Ripon, further reforms were carried out whereby the fixed annual grants were abolished and a new system of allocation was introduced. Customs, Posts and Telegraphs, and Railways which required uniformity of policy, were reserved to the Centre while other heads of revenue such as receipts from civil departments and public works were made entirely provincial.

The remaining ones such as Stamps, Excise, Income Tax, Irrigation, Registration, and later land revenue were ‘divided’ between the Centre and provin­ces in accordance with settlements made every five years. By these settlements, provincial Governments were given a direct interest not only in provincial sources of revenue but also in the divided heads raised within their jurisdiction.

The Settlement also integrated, to a considerable extent, the financial interest of the Central and provincial Governments which not only shared the receipts but also the expenditure on certain heads. But the system of ‘Divided head’ was also not free from criticism. In the first place, as AK Chanda explains, the Settlements were hardly rational.

They did not satisfy the provinces and, in-fact, exposed the Centre to the charge of discrimination. Secondly, the periodical revisions introduced an element of uncertainty in place of stability. Thirdly, the main trouble was that, at the end of each 5-year period, balances standing to the credit of a province, were resumed by the Government of India.

Inevitably, the arrangement tended to put a discount on economy on the part of the provincial Governments which incurred ill- considered or needless expenditure for no other reason than to prevent their savings from lapsing to the Centre.

In the words of Sir A Mackenzie, the normal history of provincial finance was this; “two years of screwing and saving and postponement of works, two years of resumed energy on a normal scale, and one year of dissipation of balances in the fear if not spent, they will be annexed by the Supreme Govt. at the time of revision”.

Fourthly and lastly, the five yearly settlements crystallized the financial inequalities started in 1871 as no attempt was made to bring the provincial expenditure on to a common footing of equality.

---

5. Quasi-Permanent Settlement, 1904:

Some of these defects were partly removed in 1904 when Lord Curzon’s Govt. made these settlements quasi-permanent. Under this system, revenues assigned to a province were definitely fixed and were not subject to alteration by the Central Government except in the case of extreme necessity or unless experience proved that the revenues assigned to a province were in excess of its normal needs.

However, as the expenditure of the provincial Governments generally was more than the revenues assigned to them, the difference was made good either by a fixed assignment, or an initial lump sum grant or special grant.

The quasi-permanent settlements were a great improvement upon the old system of 5-yearly revisions. Under the new system, the relations of the Govern­ment of India with the provinces improved as the bitter 5-yearly controversies in the allotment of revenues were now avoided.

But a more substantial gain was that the provinces, which were previously exposed to the risk and uncertainties of an un-favourable settlement at the end of every 5 years, now gained a more independent position and more enduring interest in the management of their resources.

---

6. Permanent Settlements, 1912:

The financial relations between the Central and provincial Govts. were ex­amined by the Decentralisation Commission (1909) which did not suggest any major change in the system. The question, however, received the attention of Lord Hardinge’s Government when the quasi-Permanent Settlements were made Permanent Settlements from 1912.

The Permanent Settlement did not introduce any change of principle in the allocation of resources except that they reduced the fixed assignments and gave the provinces larger shares in the growing sources of revenue. These settlements continued till the reforms of 1919 when Provincial finance entered upon a new phase.

It may, however, be noted that the measures of decentralisation undertaken thus far were merely transfers of powers and functions, mainly for administrative reasons and not aimed at federalism.

The Government of India continued to exercise general supervision over the proceedings of the “glorified local Governments” —The Provinces in the collection of revenues and the ad­ministration of the services entrusted to their care.

Provincial budgets still re­quired the Supreme Government’s approval. Provinces had no independent powers of taxation nor could they raise loans in the open market- – a restriction which was treated “almost as an axiom of the Indian Financial System.” Finally, the divided heads provided considerable scope for central interference in the details of provincial finance.

In-spite of these limitations, it may be admitted that the status of the provinces improved and their powers and responsibilities enlarged.

The extent of the change can be realised by the fact that “before 1870, the Governor of Bengal could make no alteration in the all allowances of public servants or establish a new school or augment the pay of a Daroga to the extent of a rupee; in 1919, the same authority could spend crores of rupees without previous reference to the Government of India”.

And yet, the reforms remained short of assuming a federal character because the basic principle of a centralised administration remained unaffected. It is not surprising, therefore, that leaders like Gokhale and S.M. Banerjee began to press for the abolition of Divided heads and demanded a complete separation of Central and provincial revenues.

---

7. The Montagu-Chelmsford Reforms:

The Government of India Act of 1919, explains M.H. Gopal, marked “a change in outlook which shifted the distant objective from decentralisation to autonomy and from a unitary to a federal state.” As a step towards financial autonomy, the “Divided Heads” were abolished and a clear-cut separation was made between the Central and provincial heads of revenue.

Under the new arrangement, the Centre was assigned Customs, Salt, Opium, Income Tax, Railways, Posts and Telegraphs, Currency, Mint, and Tributes from the native states, while the provinces were given land revenue, irrigation, Forests, Registration, Stamps and Excise duties on drugs, narcotics.

Under the Scheduled Taxes Rules, the Provinces acquired the statutory power to levy taxes listed in Schedule one without having to obtain previous sanction of the Governor-General. The Local Govern­ments Borrowing Rules empowered the Provincial Governments to float loans on the security of their own revenues.

These reforms resulted in an estimated annual Central deficit of Rs. 9.5 crores and provincial Governments gained Rs. 18.5 crores of additional revenue. A proposal was, therefore, made that the provinces should make contributions to the Government of India to meet this budgetary deficit.

A committee, named the Finance Relations Committee, was formed with Lord Meston as Chairman to advise, among other things:

(1) On the contributions to be paid by the various provinces to the Central government for the financial year 1921-22;

(2) The modifications to be made in the provincial contributions thereafter with a view to their equitable distribution until there ceased to be an All India deficit;

(3) On the future financing of the Provincial Loan Account.

---

8. The Meston Award:

The Finance Relation Committee under the chairmanship of Lord Meston proposed:

(1) A system of initial contributions which were more or less arbitrarily fixed on the basis of the increased spending powers of the Provinces. The argument was that increased revenues had come to the provinces as a windfall which correspondingly reduced the Central finances.

It was, therefore, necessary for the Central government to claim relief from the Provincial Governments in proportion to the gain made by the provin­ces.

(2) These contributions were to be reduced gradually over a period of seven years to ‘Standard’ contributions based on the principle of capacity to contribute judged by such factors as population, Income Tax receipts, Consumption of Salt, and textiles, agricultural and industrial wealth.

(3) Provinces should be given a share in Income Tax. This marked the begin­ning of the use of Income Tax as a balancing factor.

These recommendations, with certain modifications, were incorporated in the ‘Devolution Rules’ issued under the Government of India Rules of 1919. The Meston Award caused much provincial heart burning and discontent owing to the arbitrary nature of the contributions.

In the first place, contrary to expectations, the provinces were faced with a succession of heavy deficits year after year. The contributions, therefore, became a burden to the provinces which pressed for their abolition.

As a result of this pressure, they were first remitted, then suspended, and finally abolished in 1928-29. Secondly, the Meston Settle­ment made the Provinces responsible for the development of the ‘nation- building’ activities but placed only inelastic sources of revenue at their disposal. Thirdly, the contributions fixed by the committee were thought to be highly unfair and inequitable.

It was complained, though unjustifiably, that the Meston Award gave to the Centre a much larger proportion of the total revenue of the industrial Provinces than of the agricultural ones.

Bengal argued that, on account of her wealth, population, trade and industries, the monopoly of jute trade, and the port of Calcutta, her contribution to the Central government in the shape of Income Tax, Super Tax, and Customs alone far exceeded that of most other provin­ces.

Madras felt it was the ‘Milch cow’ and was proportionately contributing a larger share towards the central deficit. The weakness of this argument was that total revenues taken for comparison included Income-tax and Customs collections which obviously could not be assigned to the Provinces of Bengal and Madras.

Fourthly, it was alleged that the Settlement favoured some provinces while adversely affecting others. Land Revenue was the most important source of provincial revenue and the agricultural provinces benefitted by getting the whole of it for themselves while the industrial provinces like Bombay and Bengal suffered because they lost revenue from Income Tax which became a Central subject.

The greatest defect of the Meston Settlement lay in the fact that it created inequalities of tax burdens between different classes of the community. An average urban citizen, who did not consume country liquor or involve himself in litigation, did not contribute anything towards the provincial finances.

On the other hand, the great majority of people in the cities mainly contributed to the Central revenues although they benefitted by the activities of the Provincial Governments.

It was, as B.R. Misra puts it, “a sad commentary on the distribution of burdens between the various sections of the community.” To sum up. The Act of 1919 and the rules made under it gave the provinces considerable latitude in financial matters. They were now free to adjust the taxes on transferred heads of revenue; they similarly had the right to spend, whatever they liked, on the transferred subjects.

They were also given the freedom to float loans both in India and abroad on the security of their revenues. Despite this liberalisation, there was no separation of cash balances of the Centre and the provinces.

There was a single ‘Public Account’ on which both operated. Besides, the provinces had no control over audit and accounts. It was thus what Thomas call “a half-way house between unitary and federal” or as Chanda puts it, a situation between ‘control and autonomy’.

As regards the allocation of revenues, the system was completely federal because the revenues of the Central and Provincial Governments were completely separated.

Nevertheless, in regard to audit and accounts, borrowing, and allied matters, the provincial governments continued to depend largely on the Centre. This was somewhat anomalous but, as Thomas points out, “This was perhaps inevitable in the transition from a highly centralised to a decentralised system of Government.”

---

9. The Government of India Act, 1935:

It was in the Act of 1935 that an attempt was made to remove some of the defects of the Meston-Settlement.

The Act divided the financial resources into four categories, namely:

(a) Exclusively federal. These included, among others, Corporation Tax, Railways, Posts and Telegraphs, Currency and Coinage, Custom duties, and military receipts.

(b) Exclusively provincial such as Stamps and Registration, Sales tax, Land revenue, Irrigation, Excise, Taxes on agricultural incomes, Taxes on luxuries including entertainments and amusements.

(c) Taxes to be levied and collected by the Centre but receipts to be handed over to the provinces. These included duties in respect of succession to property other than agricultural land; taxes on railway fares and freights, terminal taxes on goods or passengers carried by railway or by air.

(d) Taxes to be shared between the Centre and the Provinces such as taxes on income other than agricultural income, Salt duties, Excise duty on Tobacco and other goods manufactured or produced in India except alcoholic liquors for human consumption, opium, Indian hemp, and other narcotic drugs, export duties on jute.

The Act also provided for a system of grants-in-aid to certain provinces out of the federal revenues. An expert committee under the Chairmanship of Sir Otto Niemeyer was appointed in 1936 to inquire into the financial position of the Provinces, the special assistance required by each and the time and mode of distributing the provincial share of income tax and proceeds of the export duty on jute.

Sir Niemeyer recommended that assistance should be given to the provin­ces in three-ways:

(a) The outstanding debts incurred before 1935 by Bengal, Bihar, Assam, the N.W.F.P. and Orissa plus approximately Rs. 2 crores of pre-1921 debt in the case of Central provinces should be cancelled.

(b) Appreciating that the jute growing provinces stood in special need of financial assistance, it recommended distribution of a further 12.5% of the Export duty on jute, thus making a total of 52.5% to the jute growing provinces.

(c) Such provinces as might be in need of assistance should be given grants- in-aid to balance their budgets. It was expected to provide “in-built flexibility.”

As regards the distribution of the proceeds of Income Tax between the Centre and the provinces, it recommended that provinces and the federated states should get 50% of the proceeds of the tax; the share of each province to be fixed partly on the basis of population and partly on the basis of the residence of the assessees.

As pointed out by Misra , Sir Otto Niemeyer’s aim throughout his recommendations was two-fold. Firstly, “he always kept in mind stability of the central finances” and secondly, “his aim was that at the inauguration of provincial autonomy, each of the province should be so equipped as to enjoy a reasonable prospect of maintaining financial equilibrium.”

His recommendations were accepted by the Government and, accordingly, an order-in-council was issued on 3 July, 1936.

These arrangements resulted in improving the financial position of the provinces and added a measure of elasticity to their revenues. In addition to introducing a clear demarcation of federal and provincial revenues, the Act also increased the borrowing powers of the provinces which could now raise loans in the open- market on the security of their respective revenues except when they wished to raise a foreign loan where previous sanction of the Central Government was required.

As was to be expected, the changes introduced by the Act of 1935 neither gave complete independence not complete satisfaction to the Provinces. In the opinion of M.R. Masani, the source of revenue were so distributed that provincial prosperity and development “was consciously subordinated to central authority and “all elastic sources of revenue were collared by the Government of India.”

All the same, the Act did introduce a very large measure of provincial autonomy in as much as it significantly improved the financial status of the provinces and gave them a large measure of independence in raising their revenues and ordering their expenditure.

The Provincial and Central balances were now separated and ‘ways and means’ became a provincial responsibility. Each province now had its own bank account with the Reserve Bank of India.

In the event of difficulty, the provinces had either to borrow from the market or obtain ways and means advances from the bank. In the field of expenditure also, the provinces were given complete freedom except that they had to keep themselves within their resources.

This was the only restriction otherwise they were given the right to have their own Auditors General and take over both accounting and auditing responsibility after giving notice. According to A.K. Chanda, “The Act of 1935 had thus not only embodied the basic principles of federal finance but had also endowed the provinces with financial power and authority which constituent units in a federation normally enjoyed.”

---

10. Provisional Adjustments, 1947-1952:

The Partition of the country in August 1945, and the separation of certain parts now forming Pakistan, necessitated a readjustment of financial arrangements between the Government of India and the provinces, especially in regard to the distribution of Income Tax and the export duty on jute.

As far as Income Tax is concerned, the basic scheme of Otto Niemeyer was retained. Only the shares of the divided provinces of Bengal and the Punjab were reduced in proportion to their reduced populations.

The resources thus released as well as the allocations to Sind and NWFP, which had completely gone to Pakistan, were now pooled for redistribution and provincial shares were re-fixed. Even here, the basis of dis­tribution among the provinces was left undisturbed.

In view of the considerable dissatisfaction that the new arrangement caused among some of the affected provin­ces, the Government appointed Shri C.D. Desmukh to look into the problem and give his award. In regard to Income Tax, Dr. Desmukh broadly adopted population as the main .basis of distribution.

As regards grants-in-aid in lieu of a share in the export duty on jute, he recommended that, pending recommendations of Finance Commission, the four concerned States should be paid certain annual payments. As a result, Bengal got Rs. 105 lakhs, Assam, Rs. 40 lakhs, Bihar Rs. 35 lakhs and Orissa Rs. 5 lakhs. The award remained in force from 1 April, 1950 to 31 March, 1952.

---

11. Federal Relations under the New Constitution:

The new constitution has so based inter-governmental financial relation “as to bring about a happy blending between federal supremacy and State autonomy.”

Broadly, the Indian constitution follows the pattern laid down by the Act of 1935. A clear bifurcation has been made of taxes to be levied by the Centre and the states. By and large, taxes with an inter-state base are under the legislative jurisdiction of the Central Government while those with a restricted base are under the legislative jurisdiction of the States.

Residuary powers, if any, have been assigned to the Union Government. There is thus no over-lapping of tax jurisdiction as is common in most of the older federations.

The taxes within the legislative jurisdiction of the Centre can be grouped under four categories:

(a) Taxes which are levied and collected by the Union Government and the revenue therefrom is also retained by it. For example, Corporation Tax, Custom duties, Taxes on capital other than agricultural land.

(b) Taxes which are levied and collected by the Centre but the revenue is shared with the States e.g., taxes on income other than agricultural and Union Excise Duties.

(c) Taxes which are levied and collected by the Centre but the entire revenue is distributed among the States, e.g., Estate duty (except on agricultural land), Terminal duties on goods and passengers carried by railways, sea or air, Taxes on railway fares and freights.

(d) Taxes which are levied by the Union but the revenue is collected and retained by the States, e.g. Stamp duties mentioned in the Union list.

The State list includes 19 sources of tax revenue such as Land revenue, taxes on agricultural incomes, excise duties on alcoholic liquors, opium, hemp, narcotic drugs, taxes on vehicles, passengers and goods carried by road or inland ways, taxes on luxuries including entertainment, amusements, betting and gambling, taxes on the sale and purchase of goods other than newspapers, taxes on professions and callings, trades and employment, animals and boats, land and buildings etc.

In order to bridge the gap between the relatively inelastic resources and expanding needs of the States, the constitution provides for a three-fold scheme:

(a) The States are entitled to a share in federal taxes, namely, taxes on income (other than corporation tax) and Union Excise duties. In regard to Income Tax, the share of the States was steadily increased by the successive Finance Commissions. The First Finance Commission fixed it at 55%; the Second raised it to 60%; the Third to 66 2/3% and the Fourth fixed it at 75% of the Income tax revenues.

As regards the principle governing the share of the individual states, the First Commission recom­mended that 80% should be distributed on the basis of population and 20% on that of collection; the Second Commission raised the former figure to 90% but reduced the latter to 10%. The Third Commission, however, reverted to the recommendation made by the First and the Fourth Finance Commission also approved it.

In the case of Union Excise Duties, the number of commodities, duties on which were to be shared with the States, was increased from 3 to 35. The Fourth Finance Commission went so far as to recommend that all Union Excise Duties (excepting regulatory duties, special excise duties and cesses earmarked for special purposes) should be shared with the States.

Although, the share of the States was reduced from 40% to 25% and finally to 20% by the Successive Finance Commissions, the divisible pool increased due to larger coverage.

(b) The States have been assigned the entire proceeds of certain taxes levied by the Union government e.g., Estate duty, the tax on railway-fares and additional Excise duties in lieu of Sales tax.

(c) The Constitution also provides for a system of grants which may be conditional or in-aid of general revenues. Such grants had tremendously increased since 1938-39 when the Provincial share of Central taxes and grants amounted to Rs Seven crores or 8.3% of Provincial revenues —to Rs. 623.72 crores in 1965-66 forming 34% of the total revenues of State Governments.

In view of the importance of Central assistance, the constitution makes what Santhanam calls “the most novel and important innovation” of a Finance Com­mission, — a semi-judicial, independent institution whose function is to make recom­mendations regarding:

(a) The division of the taxes which are to be or may be shared between the Union and the States;

(b) The distribution of the States’ share among the various States;

(c) The principles which should govern the grants-in-aid of the revenues of the States and any other matter referred to the Commission by the Presi­dent in the interest of sound finance.

As Dr. Lakadwala sums up, the Commission is expected to play the role of a Wiseman, a judge between the contacting claims of the states on the one hand and the Centre on the other. It is intended to assure the states that the distribution of finances is made by the Union government not arbitrarily but on the recom­mendations of an independent body which will assess the changing needs of the States in making them.

The Finance Commission has no parallel in federal constitutions. The only close parallel is that of the Australian Commonwealth Grants Commission which has no powers to suggest any changes in tax-sharing or the basis of distribution.

Unlike the Grants Commission, the recommendations of the Finance Commissions with regard to the sharing of the taxes and grants-in-aid have generally been accepted without modification. The First Finance Commission was appointed in 1951, the Second in 1956, the Third was constituted in 1960, and the Fourth in 1964.

One feature of the Union-states financial relations which attracted much criticism is the unbalanced division of the resources between the Union and the States. K. Santhanam’s fear that Provinces will be beggars at the doors of the centre and will have to depend on “the variable munificence or affluence of the centre” did not literally come true.

But there is no denying that almost all state governments found balancing their budgets difficult. Tax heads under the State list being neither the most productive nor flexible, most states ran deficit budgets. This led to an increased demand for better share of taxes and central assistance.

A more glaring anomaly arose with the advent of centralised Planning in India. One may not accept the often —repeated statement of K. Santhanam that “Planning has superceded the federation and our country is working as a unitary system in many respects”, but it is difficult to deny the validity of S. Tarlok Singh’s view that “national planning widens the scope of the Centre and tends to reduce the distinctions between the Central and State responsibilities.”

For one thing, the plan targets were fixed by the Central government on the recom­mendations of the Planning Commission which is neither independent nor impartial. Secondly, the plan grants, which were given for the achievement of these targets, had ‘strings’ attached in so far as they involved varying degree of central inspection and supervision of their use.

What is more, they were given in respect of a large variety of subjects which otherwise fell within the exclusive State jurisdiction. For example, the Union budget for 1959-60 provided for matching grants in respect of 60 items including general and technical education and Malaria Eradication- clearly subjects falling within the sphere of the States.

To the extent there was central control, supervision or interference in States’ subjects, there was in erosion of States’ autonomy.

No doubt, there is force an Sardar Pannikar’s arguments that “no state in India singly can undertake the multipurpose projects like Hirakud or contemplate an Iron and Steel factory like the Hindustan Steel. The costs involved, the technical skill required, the sustained Planning and execution which are essential, if these plants are to succeed are beyond the resources of a single state. This is true of most of what is being done in India to build a new society”.

But then the remedy lay in amending the constitution rather than stretch­ing or distorting it.

A more important part was played by “Plan grants” in giving a new turn to centre-state relations. The fundamental idea behind the constitutional provisions relating to distribution of taxes and the institution of the Finance Commission was that the State should get additional finance either by statutory provision or Presidential order based on the recommendation of an impartial body which would not be subject to political pulls.

In practice, however, the bulk of the resources transferred by the Union to the States were by way of ‘discretionary grants’ under Article 282.

This may be seen from the fact that, out of the total revenues of the States of Rs. 7314 crores in the Third Plan period, the grants given on the recommendation of the Finance Commission, accounted for only 4.9% while Plan grants, made without reference to the Finance Commission, accounted for 13% of the funds transferred to the States.

This was not the only departure from the pattern of Union-state financial relations embodied in the constitution. For their capital needs, the states were empowered to raise loans from the market as well as the Central Government. But the Centre, although empowered to grant loans to the states, was expected to do so only for special purposes.

On 15 August 1947, the total debt of the States to the Centre amounted to only Rs. 43.97 crores. This increased to Rs. 195.47 crores on 31 March, 1951, largely due to loans for rehabilitation. However, with the start of Planning, the Central Government became the main creditor of the stales as it was not possible for the latter to raise market loans to the extent required for the large capital expenditure of the Plans.

This may be seen from the fact that, for the first three Plans, the loans given by the Union to the States amounted to Rs. 799 crores, Rs. 1411 crores and Rs. 3101 crores respectively.

On 31 March 1966 the total outstanding debts of the States due to the Union amounted to Rs. 4000 crores. The States had used these partly for productive investments, partly for capital expenditure not yielding any revenue like buildings and roads, and partly as loans to agriculturists and Electricity Boards etc.

Thus, the scheme of financial relations, as embodied in the Constitution, had become meaningless. It is the Planning Commission and the grants and loans, issued on its recommendations, that dominated the field.

The Finance Commissions, which were originally intended to be independent bodies, had, in- effect, become secondary and subservient to the Planning Commission which, although without any constitutional footing, had acquired almost unlimited func­tions.

In fact, the Union and the State finances and even annual budgeting were controlled by the Planning Commission through its decisions on the state and Central Plans and finances. All the Finance Commissions, which reported after the inauguration of planning, had commented on the anomalies which “inevitably arise where the function of the two Commissions, the Finance and Planning, overlap.”

So long as both these commissions have to function, there is, as Lakadwala stresses, a real need for effectively coordinating their work.

It is in this context that the Third Finance Commission suggested two alternatives:

“the first is to enlarge the functions of the Finance Commission to embrace total financial assistance to be afforded to the States, whether by way of loans or devolution of resources. The Second is to transform the Planning Commission into a Finance Commission at the appropriate time.”

The first alternative ap­peared unlikely to be accepted by the government for obvious reasons while accepting the second would have amounted to supporting a unitary type of govern­ment. The process of economic development had thus created planning and decentralisation which is the Sinequa non of a federal government.

---